Mortgage Markets.ppt

1、9,Mortgage Markets,Chapter Objectives,Describe characteristics of residential mortgages Describe the common types of creative mortgage financing Explain the role of the federal government in supporting the development of the secondary mortgage market Relate the development and use of mortgage-backed

2、 securities,1.Residential Mortgage Characteristics,Residential mortgage dominate the mortgage market (see exhibit 9.1) Mortgage contract must be created which includes interest rate form (fixed or adjustable), the maturity and other special provisions According to different preference, each mortgage

3、 may have different loan structure,1.Residential Mortgage Characteristics,Federal and private insurance guarantees repayment in the event of borrower default Limits on amounts, borrower requirements Borrower pays insurance premiums Federal insurers include Federal Housing Administration and Veterans

4、 Administration,Insured vs. Conventional Mortgages,Residential Mortgage Characteristics,Fixed rate loans have a constant, unchanging rate Interest rate risk can hurt lender rate of return If interest rates rise in the market, lenders cost of funds increases No matching increase in fixed-rate mortgag

5、e return Borrowers lock in their cost and have to refinance to benefit from lower market rates,Fixed Rate vs. Adjustable Mortgages,Residential Mortgage Characteristics,Fixed monthly payment includes Interest owed first Balance to principal Interest on the declining principal balance Calculating mont

6、hly payment Principal borrowed = PV Number of months to maturity = years 12 = N Rate/12 = I Calculate PMT,Residential Mortgage Characteristics,Calculate the monthly payment for a $330,000 home. The new owner has made a $70,000 down payment and plans to finance over 30 years at the current fixed rate

7、 of 7%.,Residential Mortgage Characteristics,Calculate the monthly payment for a $330,000 home. The new owner has made a $70,000 down payment and plans to finance over 30 years at the current fixed rate of 7%. $330,000 $70,000 = $260,000 PV (original investment of the financial institution) 30 x 12

8、= 360 N; 7/12 = I; Calculate PMT,Residential Mortgage Characteristics,Calculate the monthly payment for a $330,000 new home. The new owner has made a $70,000 down payment and plans to finance for 30 years at the current fixed rate of 7%. $330,000 $70,000 = $260,000 PV (original investment of the fin

9、ancial institution) 30 12 = 360 N; 7/12 = I; Calculate PMT PMT = $1,729.79,Residential Mortgage Characteristics,Adjustable-rate mortgages Rates and the size of payments can change Maximum allowable fluctuation over year and life of loan Upper and lower boundaries for rate changes Lenders stabilize p

10、rofits as yields move with cost of funds Uncertainty for borrowers whose mortgage payments can change over time,Fixed-Rate vs. Adjustable Mortgages,Residential Mortgage Characteristics,Trend shows increased popularity of 15-year loans (See exhibit 9.2) Lender has lower interest rate risk if the term

11、 or maturity of the loan is lower Borrower saves on interest expense over loans life but monthly payments higher,Mortgage Maturities,Residential Mortgage Characteristics,Balloon payments Principal not paid until maturity Forces refinancing at maturity Amortizing mortgages Monthly payments consist of

12、 interest and principal During loans early years, most of the payment reflects interest,Mortgage Maturities,2.Creative Mortgage Financing,Graduated-payment mortgage (GPM) Small initial payments Payments increase over time then level off Assumes income of borrower grows Growing-equity mortgage (GEMs)

13、 Like GPM low initial payments Unlike GPM, payments never level off Question: the difference between GPM and GEM?,Creative Mortgage Financing,Second mortgage used in conjunction with first or primary mortgage Shorter maturity typically for 2nd mortgage 1st mortgage paid first if default occurs so 2n

14、d mortgage has a higher rate If used by sellers, makes a home with an assumable loan more affordable Shared-appreciation mortgage Below market rate but lender shares in homes price appreciation,3.Activities in the Mortgage Markets,How the secondary market facilitates mortgage activities Selling loan

15、s Origination, servicing and funding are separate business activities and may be “unbundled” Secondary market exists for loans Securitization Pool and repackage loans for resale Allows resale of loans not easily sold on an individual basis,Activities in the Mortgage Markets,Unbundling of mortgage ac

16、tivities provides for specialization in: Loan origination Loan servicing Loan funding Any combination of the above Five ways to invest in mortgage market (P223),Institutional Use of Mortgage Markets, December, 2002,Federally related mortgage pools 37% of all mortgages, mostly residential Commercial

17、banks Dominate commercial mortgage market Hold 23.3% of all mortgages Savings institutions Primarily residential mortgages Hold 10% of all mortgages Life insurance companies Commercial mortgages Hold 3% of all mortgages,Institutional Use of Mortgage Markets,Mortgage companies Originate and quickly s

18、ell loans Do not maintain large portfolios, majority of earnings are generated from origination and servicing fees Government agencies including Fannie Mae and Freddie Mac (hold large proportion of mortgages) Brokerage firms (matching up sellers and buyers) Investment banks (controlling risk by usin

19、g interest rate swaps) Finance companies See exhibit 9.6,4. Valuation of Mortgages (fixed-rate),Market price of mortgages is present value of cash flows,PM = Market price of a mortgage,C = Interest payment and PRIN is principal,k = Investors required rate of return,t = maturity,Where:,Valuation of M

20、ortgages,Periodic payment commonly includes payment of interest and principal Required rate of return determined by risk-free rate for the same maturity, credit risk and liquidity Risk-free interest rate components and relationship + inflationary expectations + economic growth change in the money su

21、pply + budget deficit,Valuation of Mortgages,Economic growth affects the risk premium Strong growth improves borrowers income and cash flows and reduces default risk Weak growth has the opposite affect Potential changes in mortgage prices monitored by reviewing inflation, economic growth, deficits,

22、housing, and other predictor economic statistics The average risk premium on all mortgages can change in response to a change in economic growth (P228),Exhibit 9.8,a,Risk from Investing in Mortgages,Interest rate risk Present value of cash flows or value of mortgage changes as interest rate changes

23、Long-term fixed-rate mortgages financed by short-term funds results in risks Holding until maturity can create an opportunity cost To limit exposure to interest rate risk Sell mortgage shortly after origination (but rate may change in that short period of time) Make adjustable rate mortgages,Risk fr

24、om Investing in Mortgages,Prepayment risk Borrowers refinance if rates drop by paying off higher rate loan and financing at a new, lower rate Investor receives payoff but has to invest at the new, lower interest rate Manage the risk with ARMs or by selling loans,Risk from Investing in Mortgages,Cred

25、it risk can range from default to late payments Factors that affect default Level of borrower equity Loan-to-value ratio often used Higher use of debt, more defaults Borrowers income level Borrower credit history Economic conditions Lenders try to limit exposure to credit risk,Risk from Investing in

26、 Mortgages,Loan to value ratio The loan-to-value (LTV) ratio expresses the amount of a first mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower wants $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000/$150,000 or 87%.(LTV) Loa

27、n to value is one of the key risk factors that lenders assess when qualifying borrowers for a mortgage.,Risk from Investing in Mortgages,The risk of default is always at the forefront of lending decisions, and the likelihood of a lender absorbing a loss increases as the amount of equity decreases. T

28、herefore, as the LTV ratio of a loan increases, the qualification guidelines for certain mortgage programs become much more strict. Lenders can require borrowers of high LTV loans to buy mortgage insurance to protect the lender from the buyer default, which increases the costs of the mortgage.,Risk

29、from Investing in Mortgages,Measuring risk Use sensitivity analysis to review various “what if” scenarios covering everything from default to prepayments Incorporate likelihood of various events Review effect on cash flows Institution tries to measure risks and use information to restructure or mana

30、ge risk See exhibit 9.10,5. Use of Mortgage-Backed Securities,The reasons for appearance of securitization The amount of single mortgage is too small to be wholesaled (institutional investors are not willing to trade so small business) The lack of standard form which prevent mortgage from being trad

31、ed in the secondary market The cost of mortgage is high (tax fee, insurance fee and account maintenance fee) Mortgage has potential credit risk (issuer is not willing to evaluate the borrowers credit),5. Use of Mortgage-Backed Securities,Securitization is an alternative to the outright sale of a loa

32、n Group of mortgages held by a trustee serves as collateral for the securities Institution can securitize loans to avoid interest rate risk and credit risk while still earning service fees Payments passed through to investors can vary over time,5.1 Use of Mortgage-Backed Securities,Ginnie Mae mortga

33、ge-backed securities Government National Mortgage Association Guarantees timely interest and principal payments to investors Pool of loans with the same interest rate Purchasers receive slightly lower rate than that on the loans to cover service and guarantee,5.2 Use of Mortgage-Backed Securities,Fa

34、nnie Mae mortgage-backed securities Uses funds from mortgage-backed pass-through securities to purchase mortgages Channel funds from investors to institutions that want to sell mortgages Guarantee timely payments to investors Some securities strip (securitize) interest and principal payment streams for separate sale,5.3 Use of Mortgage-Backed Securities,Publicly issued pass-through securities (PIPS) Backed by conventional mortgages instead of FHA or VA mortgages Private mortgage insurance Participation certificates (PCs) Freddie Mac sells and uses funds to finance origination of conventiona